Risk sharing

Macroeconomic crises and shocks often cause large and unforeseen income and employment losses. Such losses tend to be unevenly spread across the population, often with the greatest impact on the poor and most vulnerable sections of society. This chapter presents new OECD analysis of the types of policies that have helped to protect the most vulnerable.

The recent crisis has been a forceful reminder that economies are still at risk of being affected by – sometimes violent – shocks. The economic implications of such shocks can vary markedly across the population. For example, young people have been particularly badly hit by the recent financial crises, with their unemployment rate increasing twice as much as the overall rate across the OECD and the BRIICS. Such dissimilar implications of macroeconomic shocks reflect in part the greater sensitivity of certain groups to general economic conditions, but they are also likely to depend on policies and institutions. For instance, during the recent financial crisis youth unemployment increased more in countries with higher statutory minimum wages (see figure below), and more rigorous analysis confirms that this was more than mere coincidence.

Young people have been particularly badly hurt by the recent financial crisis, and especially so in countries with high minimum wages

More generally, institutions shape the distributional effects of macroeconomic shocks. Some of the institutions that improve risk-sharing are also good for growth or jobs, thereby providing obvious directions for reforms. Examples are well-designed short-time working schemes, competitive product markets, low taxes on labour, and prudent fiscal policy. Others, such as high minimum wages or strict job protection, can come at a cost, and particular care is therefore needed in designing them.

The OECD analysis identifies two broad types of institutional set-ups for sharing income risk, namely “social protection” and “reallocation-facilitating” institutions. Social protection institutions include unemployment benefits, job protection, minimum wages and strong unions. Pro-competitive product market regulation and low tax wedges on labour are examples of institutions that help to share risk by enabling resources and workers to be reallocated more easily. Based on these two institutional set-ups, OECD and BRIICs countries are categorised into four broad groups:

(i) Countries that provide income risk sharing mainly via social protection institutions, such as most countries of continental Europe.
(ii) Countries that rely mainly on reallocation-facilitating institutions, such as English-speaking and Asian OECD countries.
(iii) Countries where neither class of institutions are developed, typically OECD and non-OECD emerging economies.
(iv) Countries that rely strongly on both types, mainly the Nordic countries.

A stylised classification of risk-sharing models across the OECD and the BRIICS